Personal Finance & Money Asked by Nosjack on April 25, 2021
My wife and I are foster parents, and long story short we are planning to adopt three kids this year. In anticipation of this I went ahead and considered the kids as dependents for 2021 and updated my W4 at work. We already have one biological child.
Interestingly, going from one child to four apparently means that I now pay $0 in federal taxes. Previously I was paying about $113 per paycheck (about $2,940 annually). Gross income is about $72,000 annually. The simple math makes sense with the child tax credit: $2,000 x 4 = $8,000 which is much more than what I was paying annually in taxes. But, I’m worried that there is some sort of cut-off or minimum tax payment that I should look out for.
Is paying nothing to the Fed okay if my tax credits are large enough? My gut says that at my income level I should be paying something (but I’m okay if I don’t have to…)
You pay $3k in taxes now and are adding $6k in credits, so it makes sense that you'd pay no taxes. In fact, the CTC is refundable up to $1,400, so you'll probably get a significant refund instead.
There is no cap on the number of children, just an income cap that you are below. There is an "Alternate Minimum Tax", but the purpose of that code is to ensure that high-income taxpayers don't overuse certain deductions - it should not apply to foster parents in your income range.
Correct answer by D Stanley on April 25, 2021
If this is the case, and you have any pre-tax retirement money, now is the time to consider Roth conversions. Not all at once, of course, but just enough so you would pay perhaps 10% on some of the conversion. If your taxable income is being sent negative you are losing a benefit you can gain back by converting that amount each year.
Inspired by Brian's comment - for those in this situation, Choose a Roth flavor IRA or 401(k) for new deposits. If the Roth 401(k) isn't an option, but the traditional 401(k) offers matching funds, deposit no more than the matched amount. Why withhold money 'pretax' when it wasn't going to be taxed anyway, and will grow to be taxed on withdrawal?
Further - If the employer has Roth and traditional 401(k) options. If the year-end numbers (i.e. the tax return) would still show a negative income, despite using the Roth side for deposits, note that matching funds are considered pre-tax. A conversion from the Tradition side to the Roth side of the 401(k) can take advantage of that as the conversion is considered 'income'. One can aim to zero out their tax liability, or push into the 10% bracket. Tough to give exact numbers as we don't know age of taxpayer, income, current retirement assets etc, but I do know that once the kids are over 18, the credits/deductions go away. That's the time to load savings via pretax accounts. And paying 10% now to convert will seem like a bargain.
Answered by JTP - Apologise to Monica on April 25, 2021
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